What does NFRA’s investigation report into EY’s IL&FS audit mean for auditors?, CFO News, ETCFO

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By: Soham Shah

Last week, India’s accounting watchdog released a 389-page Audit Quality Review (AQR) report on the statutory audit of EY member firm SRBC and Co LLP of IL&FS for financial year 2018. The National Financial Reporting Authority (NFRA) found significant deficiencies in the SRBC audit. He attacked the audit firm, saying his appointment was illegal and compromised his independence.

NFRA said the Ernst & Young group, of which SRBC is a part, provided prohibited services to IL&FS and also had a business relationship with the auditee, adding that by undertaking an audit of IL&FS, the auditing firm violated independence standards.

Further, the regulator pointed out that the auditing firm and its associates received non-audit service fees amounting to ₹4.57 crore in 4 years, starting in 2015-2016, as opposed to to audit fee income of ₹2.3 crore received for carrying out the statutory audit for FY18 and said this goes to the very root of SRBC’s independence or conflict of interest. ETCFO spoke to industry experts to decipher the impact of this audit quality review report on auditors in the future.

Auditors are becoming more cautious

“The question of a conflict of interest among auditors is common. The NFRA, in its previous AQRs, has also highlighted this independence issue. The regulator’s latest report should make auditors more cautious. Auditors should ensure, before undertaking any audit, that their parent entity or any related entity does not provide any non-audit related service that is otherwise prohibited to auditors to ensure conflict of interest,” said one. senior audit professional, who did not wish to be identified, ETCFO said.

ETCFO explains: What does the NFRA investigation report on EY's IL&FS audit mean for auditors?A conflict of interest arises in the first place since auditors are considered conflicted to challenge management or find deficiencies in financial reporting if their company has also accepted more lucrative consulting work with the same client.

The Companies Act 2013 provides certain safeguards to ensure the independence of auditors; Section 144, for example, lists certain non-audit services prohibited to auditors. These include bookkeeping, management services, internal audit, investment advisory, and more. What all constitute ‘management services’, however, has long remained a question and subject to differing interpretations by regulators and auditors.

The auditor quoted above further said that the profession needs to dig deeper into the NFRA report, study the findings carefully, and then incorporate the lessons. “This report can actually serve as a bible to listeners. Additionally, auditors need to be more professionally skeptical in the future and increasingly need to look beyond the numbers,” he said.

The audit partner also advised that the current list of prohibited non-audit services or representations is sufficient to ensure the independence of auditors and that there is no need to outright prohibit services non-audit related for listed audit clients, as offered by some chapters of the fellowship. “I don’t know how a firm will survive (without non-audit services). It has to be a decent mix (of audit and non-audit services) and ensure that any non-audit work done is not related to financial statement reporting,” he said.

NFRA found several deficiencies in SRBC’s IL&FS audit. He said that not only was the audit firm’s appointment as auditor of IL&FS unlawful, but that he also failed in the auditing of investments, loans and advances and income, and that it had not complied with auditing standards.

“In the opinion of NFRA, the auditing firm did not have adequate justification for issuing the audit report asserting that the audit was performed in accordance with SA (auditing standards) and that the financial statements provide a true and fair view, and audit quality is seriously compromised due to widespread non-compliance with professional standards and regulatory and legal requirements, and improper reporting by the audit firm,” said the NFRA.

“Had the audit firm been vigilant, exercised professional skepticism, sufficiently challenged management’s assumptions and assertions, and strictly complied with its audit responsibilities, such failures on the part of IL&FS could perhaps have been detected much earlier and the tens of thousands of crores of hair loss and haircuts. that banks, creditors and investors ultimately grappled with would have been avoided,” the NFRA added.

SRBC, however, says it is evaluating the NFRA report. Following the release of the AQRR, it released an official statement: “Over the past three years, SRBC & Co LLP has cooperated fully with NFRA. We are currently reviewing the audit quality review report. We remain confident in our audits which were conducted in accordance with applicable laws and professional standards,” the audit firm said.

Implications for companies, investors

Shriram Subramaniam, chief executive of proxy advisory firm InGovern, said caution would be needed not only among auditors, but also among companies.

Now companies are becoming much more careful when appointing auditors. The concept of auditor rotation has helped… Also, investors are likely to take a closer look at audit reports. They no longer think that if one of the big four accounting firms (Deloitte, EY, KPMG, PwC) does the audit, it (the audit) is kosher.Shriram Subramaniam, Founder and Managing Director, InGovern Research Services

A senior finance official, who did not wish to be identified, said the NFRA report was clearly indicative of a disappointing audit by the SRBC. To him, it seems the auditing firm simply knowingly ignored the financial misdeeds of the IL&FS.

“From the NFRA Audit Quality Review Report, it seems clear to me that the auditor failed to perform basic due diligence. There are so many inconsistencies and I’m sure the auditor must have been aware of them. The regulator found many red flags such as negative equity, but the auditing firm ignored them. Forget the good job, the auditor didn’t do a decent job at all,” this expert said.

“Companies will hopefully now be more aware that apart from their auditors, someone else can also view their accounts. Hopefully companies will strengthen their corporate governance framework. Companies that are not not clean would be unhappy (with the NFRA report),” the finance veteran added.

The background

The NFRA reviewed the SRBC audit following a referral from the central government on September 25, 2019. It previously completed audit quality reviews of two of IL&FS’ main subsidiaries, namely IL&FS Financial Services Ltd for the financial year 2017-18 (joint audit by Deloitte Haskins and Sells LLP, Chartered Accountants and BSR and Associates LLP, Chartered Accountants) and IL&FS Transportation Networks Ltd (audited by SRBC & Co LLP) for the same exercise. In these reviews as well, NFRA found the appointments of auditors to be illegal.

The NFRA is an accounting regulator, set up by the government in 2018 following the collapse of the IL&FS. Its objective is to monitor compliance with auditing and accounting standards in large public entities and audit firms and to improve the financial reporting of companies as a whole. It was modeled after the accounting regulators Public Company Accounting Oversight Board (PCAOB) in the United States and Financial Reporting Council (FRC) in the United Kingdom.

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